To Deduct Or Not? Ruling Muddies Waters

Last summer, the United States Tax Court ruled that a student’s expenses made while getting an EMBA — including tuition — could be deducted come tax time. Last month, in a new case, the court ruled the other way — and a Columbia Business School professor is troubled by the precedent the decision may set.

Robert Willens tells Poets&Quants that the latest case, Megan Zhao Creigh and John L. Creigh v. Commissioner, involves a woman who tried to deduct $59,282 for tuition, fees, and associated education expenses for an EMBA from UCLA’s Anderson School of Management. Megan Creigh, who received her degree in 2013, also sought to deduct nearly $5,000 in car and truck expenses for travel to classes, programs, and events. The Internal Revenue Service said no, and slapped her with a penalty of more than $3,500.

The court sided with the IRS, and the decision can’t be appealed.

A NEW, TROUBLING FOCUS

More troubling than the case’s “‘bad’ set of facts” is the way the ruling was justified, Willens says. Megan Creigh, a former software engineer, told the court she sought the EMBA to jump-start her independent consulting business by “networking” potential clients among her classmates; the IRS cited Section 162, a rule that says for education expenses to be deductible, a taxpayer must be “presently engaged” in a related trade or business and not seeking qualifications for a new trade or business. So far, seems about right.

However, Willens says, a potentially thorny issue for future cases arises in two of the court’s actions in denying Creigh’s deductions: the ruling’s focus on classes Creigh took at UCLA and the observation that many, if not most, were unrelated to her prior endeavors; and the court’s rejection of the previously accepted notion that the pursuit of an EMBA is only a temporary cessation of one’s trade or business.

“I still think most EMBAs should have no problem securing a deduction for their tuition, etc.,” says Willens, who advises students on their tax options as part of his Investment Banking Tax Factors class at Columbia, where he has taught since 1993. “However, one thing troubles me about the case. The court focused on the courses she took and noted that many, if not most, were unrelated to her prior endeavors.”

Columbia Business School professor Robert Willens. Courtesy photo

‘ENGAGING IN A TRADE OR BUSINESS’

IRS Section 162 is a thick tangle of subsections, exceptions, and special rules, but the law is pretty straightforward as it pertains to EMBAs and other educational expenses, and the thrust is this: To be deductible, the education you receive can’t be put toward the pursuit of a new trade or business. In Megan Creigh’s case, the Tax Court ruled she didn’t meet that standard because in her prior employment, her tasks and skills centered on analyzing and designing computer software systems, whereas the EMBA courses she completed “were varied and encompassed a large number of business fields.”

“The court disallowed the deductions because, in her case, the education qualified her for a new trade or business,” Willens says. “The EMBA enabled her to perform ‘tasks and activities’ substantially different from those she had performed in her existing business. To add insult to injury, the court upheld the I.R.S.’s imposition of penalties. It found that she did not have reasonable cause and did not act in good faith when claiming the deduction.”

Then there’s the question of engagement. Ordinarily, Willens says, when someone is engaged in a trade or business before going to school, and their intent is to resume that trade business after graduation, they have no problem deducting their expenses later. But in the Creigh case, “What the court did was to say, ‘We’re not even going to bother deciding the question of whether she is or is not engaged in a trade or business, we’ll take the path of least resistance here and disallow the expenses on the theory that the education qualified her for a new trade or business.’”

ANOTHER TROUBLING ASPECT OF THE NEW CASE

After last August’s ruling in Kopaigora v. Commissioner, Willens noted that the courts seemed to have accepted the argument that business school is only a “temporary cessation or a hiatus in the conduct of the trade or business,” one that will end with the student returning to the trade or business from which he or she came after matriculating at school. He also observed that that case, which also involved an EMBA, had ramifications for seekers of regular MBAs, because they usually must suspend their careers while seeking the degree.

But back then Willens noted that “there’s no shortage of cases — they can bring other cases,” and that there have been “a surprisingly large number of MBA cases through the years. (The IRS will) still bring cases where they feel like they have the facts to win the case, so while this case can’t be appealed, they’ll find another one, no doubt.”

They found one. And the most troubling aspect of the ruling, Willens says — after the apparent rejection of the argument of a temporary educational hiatus — is a course-by-course judgment on what tasks Creigh’s education qualified her to perform.

“If courts took this approach with other EMBAs and regular MBAs as well, they might find that, say, a person in investment banking, who intended to go back to banking after graduation, nevertheless qualified for a new trade or business simply because she took a marketing course or other courses unrelated to banking,” Willens says. “I don’t think things will come to that, but you can read this current case as supporting such an approach.

“Does taking a course in marketing qualify you to become a professional marketer? The court seems to be implying that that’s the case. Does taking a finance course all of a sudden qualify you to become an investment banker or corporate finance specialist? I think the answer is no, but the court seems feel that taking these courses in and of itself qualified her to pursue any one of those lines of endeavor. That bothers me more than a little bit.”

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